Expenses & Deductions
The IRS recently issued Chief Counsel Advice (CCA) 201302018, which provides that, for purposes of the uniform capitalization (UNICAP) costing rules under Sec. 263A, a sale is considered “ on-site ” only when the retail customer is physically present at the sales facility at some point during the sales transaction. The level of on-site sales at a facility determines whether the facility is treated as a retail sale or dual-function storage facility. The UNICAP rules do not require taxpayers to capitalize handling and storage costs incurred at retail sales facilities or at dual-function storage facilities to the extent they are attributable to property sold in on-site sales.
Although a CCA memorandum cannot be used or cited as precedent, the IRS’s conclusions in the CCA may be helpful to retailers in analyzing whether certain sales transactions qualify as on-site sales.
Sec. 263A requires taxpayers to capitalize into inventory certain direct and indirect costs to the extent that such costs are allocable to resale activities. Common indirect costs incurred by retailers include purchasing, handling, storage, and related administrative costs. The regulations generally permit retailers to deduct the amount of handling and storage costs that are attributable to a “retail sales facility” but require them to capitalize the costs attributable to non-retail sales facilities. These rules are described in more detail below.
Handling costs generally must be capitalized and include costs attributable to processing, assembling, repackaging, transporting, and other similar activities with respect to property acquired for resale. However, handling costs incurred at a retail sales facility, including unloading, unpacking, marking, and tagging goods for retail sales, are not subject to capitalization. A retail sales facility is defined as a facility where a taxpayer sells merchandise exclusively to retail customers in on-site sales (i.e., sales made to retail customers physically present at a facility). In addition, handling costs incurred at a dual-function storage facility are not required to be capitalized to the extent they are attributable to property sold in on-site sales (see Regs. Secs. 1. 263A-1 (e)(3)(ii)(G), 1. 263A-3 (c)(4)(i), and 1. 263A-3 (c)(5)(ii)).
Storage costs also generally must be capitalized and include the costs of carrying, storing, and warehousing property. Storage costs must be capitalized if they are attributable to an off-site storage or warehouse facility or are allocable to the portion of a dual-function facility attributable to off-site storage. All costs attributable to an on-site storage facility or allocable to the portion of a dual-function facility attributable to on-site storage may be currently expensed, including labor and occupancy costs such as depreciation, rent, utilities, taxes, security, and maintenance. The regulations define an on-site storage facility as a storage or warehouse facility that is physically attached to, and an integral part of, a retail sales facility (see Regs. Secs. 1.263A-1(e)(3)(ii)(H) and 1.263A-3(c)(5)).
The following are examples of facilities that typically qualify as on-site storage facilities:
- A backroom furniture warehouse attached to a showroom. Even though retail customers do not enter the warehouse, it is physically attached to and an integral part of the facility.
- Auto dealership lots separated from the main dealership facility, provided customers select automobiles from both lots (see Regs. Sec. 1.263A-3(c)(5)(ii)(B)(2) and Rev. Proc. 2010-44).
- Home improvement centers that occasionally sell to other retailers (e.g., contractors) as well as end users of merchandise.
The following are examples of facilities that typically do not qualify as on-site storage facilities:
- Catalog and mail-order centers. Even though their customers are exclusively retail customers, the sales are not made to customers who are physically present (see Regs. Sec. 1.263A-3(c)(5)(v), Example (1)).
- Pooled stock facilities used for regional distribution. Even though these facilities function as backup storage for sales that are made at nearby retail outlets, the storage facilities are not physically attached to outlets (see Regs. Sec. 1.263A-3(c)(5)(v), Example (2)).
In CCA 201302018, the IRS provides examples to clarify the types of transactions that qualify as on-site sales under Regs. Sec. 1. 263A-3 (c)(5)(ii)(D). The examples demonstrate that a retail customer must be physically present at the sales facility at some point during the sales transaction for the sale to qualify as an on-site sale.
Situation 1: A retail customer physically visits the sales facility to select, inspect, and purchase goods. The customer takes possession of the goods at the time of the sale. This qualifies as an on-site sale because the customer was physically present at the sales facility for the entire sales transaction.
Situation 2: The facts are the same as Situation 1 except that the customer fills out a purchase order form at the sales facility agreeing to pay for the goods upon delivery at a later date. This situation qualifies as an on-site sale because the customer was physically present at the sales facility to select and inspect the goods and to fill out the purchase order form. The fact that the customer did not pay for or take possession of the goods at the sales facility does not preclude this transaction from qualifying as an on-site sale.
Situation 3: A retail customer selects and purchases goods from the sales facility over the internet. The customer physically visits the sales facility to inspect and take possession of the goods. This situation qualifies as an on-site sale because the customer was physically present at the sales facility to inspect and take possession of the goods. The fact that the customer did not select or purchase the goods at the sales facility does not preclude this transaction from qualifying as an on-site sale.
Situation 4: A retail customer selects and orders goods advertised in a catalog by mail from the sales facility, and the goods are delivered to the customer. The customer does not physically visit the sales facility at any time during the sales transaction. This situation does not qualify as an on-site sale because the customer was never physically present at the sales facility. Note that this conclusion is consistent with the example in Regs. Sec. 1. 263A-3 (c)(5)(ii)(D), which provides that mail-order and catalog sales are not on-site sales since they are made to customers not physically present at the sales facility.
CCA 201302018 provides that a retail customer is not required to be physically present at a sales facility for the entire sales transaction for it to qualify as an on-site sale. The CCA does confirm, however, that the retail customer needs to be physically present at some point during the sales transaction (e.g., during selection, inspection, purchase, or possession). The CCA does not specifically address the treatment of internet sales in which the customer is never physically present at the retail sales facility, although internet sales seem comparable to catalog sales addressed in Situation 4, above.
Retailers should examine their Sec. 263A calculations to determine whether they are correctly applying the on-site sales definition in determining capitalizable storage and handling costs. In particular, retailers should review their in-store pickup sales resulting from internet and catalog purchases and in-home delivery sales for items selected (and potentially purchased) in a sales facility. Both types of transactions may qualify as on-site sales under this guidance, although taxpayers and their advisers should bear in mind that a CCA memorandum cannot be used or cited as precedent. One of the challenges for retailers may be whether they can properly trace these transactions to the sales facilities.
If a retailer determines that a change in method of accounting is required, it will need to file Form 3115, Application for Change in Accounting Method . Depending on the facts and circumstances, the method change may qualify as an automatic change under Section 11.01 of the Appendix of Rev. Proc. 2011-14 .
Mary Van Leuven is senior manager, Washington National Tax, at KPMG LLP in Washington, D.C.
For additional information about these items, contact Ms. Van Leuven at 202-533-4750 or email@example.com.
Unless otherwise noted, contributors are members of or associated with KPMG LLP. This article represents the views of the author or authors only and does not necessarily represent the views or professional advice of KPMG LLP. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.